Budget 2017: pre-budget briefing by Parliamentary Budget Office

21 February 2017

Chairperson: Mr Y Carrim (ANC); Co-Chair: Ms Y Phosa (ANC)

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Meeting Summary

A pre-budget briefing was given to the four finance committees by the Parliamentary Budget Office (PBO). The presentation highlighted lower-than-expected revenues as a key challenge facing the fiscus. Also discussed were the main avenues of expenditure, the trajectory of the budget and the potential tools available to government to reduce the deficit.

Members’ questions focused on a concern that a Value Added Tax hike might be announced which could have harmful effects on the poor. Several members felt that VAT was not a desirable option as it is regressive in this fashion. Members discussed other potential avenues through which revenue could be raised. These included taxes on sugar, carbon emissions, luxury goods, fuel levy and higher corporate income tax rates. Members also asked about the impact of a stimulatory fiscal policy and the role that government could play. What things could be done by government to change fiscal policy to favour growth? The comment was made that it was not useful to speak about tax policy changes before an impact analysis was done on the fiscal policy to be implemented. Also noted was that there is no fiscal discipline in many of the government’s departments and addressing this problem alone could provide the R17.6 billion needed for higher education.

The PBO conceded that VAT was somewhat regressive, although protective measures can be taken to assist the poor, such as zero-rated items. PBO did not make specific comments about what could be expected in the Minister of Finance’s Budget Speech to be given the following day. They did indicate that a VAT hike seemed likely in the near future due to extreme pressures on the budget.

Meeting report

Prof Mohammed Jahed, PBO Director, said the goal of Budget 2017 is to produce radical socio-economic transformation and inclusive growth in favour of the poor. This goal derives from the goals mentioned in the President’s State of the National Address on 7 February 2017.

Prof Jahed said a ‘fragile’ level of economic growth is likely to occur in 2017. This is driven by an increase in international commodity prices, growth in the agricultural sector and modest international economic growth. He noted that South Africa’s growth tends to be tied to the growth of the world economy and the emerging market economies. South Africa is underachieving relative to other emerging economies in terms of per capita growth.

Prof Jahed explained that the fiscal framework shows revenue underperforming leading to shortfalls in the overall balance. There is a necessity to change policy to address this. The revised shortfall is R165 billion. There is a consistent effort to reduce the deficit; expenditures are projected to reduce by R20 billion and an additional R28 billion will need to be collected in revenue. So far spending is on track at around 75%.

Prof Jahed explained that revenue grew slower than expected in 2016 which put pressure on the budget. There was a R23 billion shortfall in collection. Tax revenue grew by 7.7% which was 2% lower than expected in the Budget Review of 2016. National Treasury’s Medium-Term Budget Policy Statement (MTBPS) in October 2016 mirrored this shortfall. The average difference between the Treasury forecast for overall tax revenue and what has actually been collected was R10.25 billion. The shortfall could turn out to be anywhere between R13 and R33 billion. It is better to plan around this range than to expect the exact figure of R23 billion to be true.

Prof Jahed explained that the revenue shortfall has prompted Treasury to seek new means of raising revenue. Initially the aim was for an additional R15 billion, but this was ramped up to R28 following the MTBPS. There are several tax options available but none are simple. There are also issues around efficiency and equity. There are principles government can try follow such as the benefit principle and the ability to pay principle. One needs also to consider the domestic and global environment.

Prof Jahed discussed pressures on the budget with health, education and electricity primary among these. Priority sectors for spending are social services and infrastructure. Education receives the highest spending followed by Economic Affairs and Human Settlements. Debt service costs seem to be growing. South Africa needs fundamental change, but where do we start? Expenditure efficiency measures are an option but more transformative changes may be necessary. One area for example is the issue of unspent monies in government, around R1.3 billion. There are simultaneously several vacancies in government.

Mr Dumisani Jantjies, PBO Deputy Director of Finance, made the presentation which covered the fiscal framework as at December 2016; tax revenue: year to date performance and revenue raising possibilities; expenditure: spending pressures and priority spending plus proportions of allocations per function; efficiency measures and the adjustments budget process. (see document). He explained that the PBO had intended to present on the effects of a potential increase in Value Added Tax (VAT). However, the study was not ready for presentation due to other commitments. VAT is not an isolated tool and must be considered within a basket of policies.

Mr Carrim voiced his displeasure that a potential VAT raise was not to be discussed as this was part of the mandate given to the PBO for the meeting. He asked why the VAT study was not available.

Mr Jantjies responded that the study had been finalised but that the presentation itself had not been completed.

Mr Carrim again expressed displeasure as another separate meeting for VAT was not feasible. There was a possibility that a VAT hike could appear in the Minister of Finance’s Budget Speech the following day. He requested a hardcopy of the VAT study.

Mr Jantjies agreed to speak to the results from the study although they were missing from the presentation. He stated that there is broad consensus that VAT is a relatively regressive tool. VAT is a form of tax that can significantly affect the poor. At the same time, South Africa has several measures in place to protect low-income households. There is a basket of zero-rated goods that are not taxed in terms of VAT. An issue that remains is that the basket of goods that are zero-rated was created in 1990 and it is somewhat outdated and therefore not efficient today. For instance, brown bread is zero-rated yet the poor increasingly consume white bread.

Mr Jantjies explained that a 1% raise in VAT is expected to create R10 billion in revenue. However, there is another implication in that a 1% rise in VAT pushes inflation up by 0.5%. A benefit is that there is a relatively small administrative cost associated in increasing the VAT rate as the VAT tax system is already in place. Certain items in the zero-rated basket are consumed by all households regardless of income, which is inefficient for revenue collection. The burden of a VAT increase would still most strongly land on the poor; the zero-rated basket is not as effective in protecting the poor as one would hope. Expanding the basket would be useful to help protect the poor.

Mr Jantjies explained that increasing VAT reduces aggregate demand. When one increases VAT, it can be contractionary to the economy. This is more likely to be harmful if the income passed to government is not then recycled back into the economy. The increase in inflation is short-term and inflation will normalise in the long-term. Compared to other countries, South Africa has a relatively low VAT rate. The African average is 15%, whereas South Africa is at 14%. South Africa is also low relative to the world average. However, there is the balance between direct and indirect tax to be considered: In South Africa, direct tax is relatively high which counterbalances the low indirect tax of VAT. So again, it is important to the tax system as a whole and not to look at any part in isolation.

Discussion
Mr D Maynier (DA) asked what PBO’s growth forecast was and what implications the forecast had for revenue. Treasury predicts a shortfall of R28 billion, yet PBO predicts a range of R13-R33. Please expand on this. Secondly, does PBO expect an increase in VAT to be announced by the Minister tomorrow? Do you consider VAT a regressive tax?

Mr S Buthelezi (ANC) asked why the zero-rated items did not have the appropriate effect of protecting poor households. He asked if PBO had considered the implementation of a tax on luxury goods. He asked why PBO had focused on per-capita GDP as opposed to GDP. Finally, he asked if inflation would still fall within target, and whether the inflation forecast had been factored into the revenue forecasts.

Mr T Tobias (ANC) stated that a fundamental issue was fiscal policy. She wanted the PBO to speak about the stimulatory role that government could play in the economy. She felt it was not useful to speak about tax policy changes before the PBO provided an impact analysis on the fiscal policies that may be implemented. This information was necessary to inform tax policy decisions.

Mr A McLoughlin (DA) noted that debt service costs seemed to have gone down. He asked if this was because the country had less debt than expected; or worse, the country was in arrears in paying its debts. Why was an increase in capital gains tax not mentioned as a potential tool on slide 11? If there is an increase in VAT, why does it have to be 1% and not, for example, a higher amount?

An unidentified committee member asked if there were any benefits from the expected strengthening of the Rand and lower than expected inflation. Secondly, if the VAT increase is offset by the zero-ratings basket, why bother to implement the increase? Is there no consideration for increasing corporate income tax?

Mr A Shaik-Emam (NFP) felt that the cons of the VAT hike far exceeded the pros, and that the effect would be devastating for the poor. He asked if PBO had any other advice for collecting more revenue. He was also concerned by the debt service costs. He felt that reducing spending inefficiencies was an important way in which the deficit could be managed. Collusion within the banks and retailers was impacting the economy negatively.

Mr F Shivambu (EFF) asked from which sectors the largest amounts of corporate income tax came. He sought to understand the usual percentage of corporate tax collected vis-à-vis the size a country’s GDP growth. Specifically, if GDP is x, how much tax should one usually collect? He felt the country was not collecting a normal amount of taxes. He felt that in the informal economy, businesses often owed by non-nationals were trading goods but not paying taxes.

Mr N Kwankwa (UDM) agreed with Mr Shivambu. He added that tax and VAT falls disproportionately on the poor. There should be study to show that an increase in VAT is less destructive than another hypothetical tax before the country chooses to implement a higher VAT rate. Some zero-rated items are incorrect (should not be zero-rated). Additionally many poor consumers were not aware of which items were zero-rated. The basket of goods bought by the poor goes far beyond the zero-rated goods, so the argument that this basket protects the poor does not hold.

Ms S Shope-Sithole (ANC) was of the view that the poor and in particular the rural poor would be most harmed by a VAT hike.

Dr M Khoza (ANC) commented on the R17.6 billion needed for spending on higher education, saying there is no fiscal discipline in many of the government’s programmes. She felt that addressing this problem alone could provide the R17.6 billion. On slide 15 of the presentation, travelling and social events is mentioned. It has been found several times that these events are rife with corruption and illicit tender practices. She asked how much was being wasted on these unnecessary events and how they could be stopped.

Mr F Essack (DA) felt that part of the solution may lie in a re-design of corporate taxes. [Audio failure at this point but sound soon returns.]

Mr Carrim asked what method had been used to arrive at the revenue shortfall mentioned on slide 8. Why is the bracket so wide for the estimate of revenue shortfall? He commented that a problem can arise in the case of zero-rated items if retailers do not inform their consumers and ignore that these goods should be exempted. He asked if there was something that could be done to ensure that the goods exempted in the zero-rated basket actually end up being exempted when the consumer buys then. He felt that the basket should be bigger and that luxury goods should be taxed more. He asked why the Davis Tax Committee was opposed to VAT. He asked what other countries with high levels of inequality do within their VAT system to protect the poor.

Prof Jahed expressed worry that the current trajectory of the budget was not satisfactory. He noted that other countries that are advanced countries have a higher government spend yet these are not described as socialist. The policy objectives of fiscal policy since 1994 have largely been counter-cyclical in pursuit of stabilisation. There is a balance between growth and social security. Government spending is important and should be evaluated as a percentage of GDP. In South Africa we spend 30% of GDP which is lower than other comparable countries. South Africa should consider re-evaluating its fiscal and monetary policy.

Mr Rashaad Amra, PBO Economic Analyst, explained that there has been a clear strategy in terms of counter-cyclical spending. A lot of the growth in debt has been caused in undesirable sectors such as consumer debt and speculative trading on the stock market rather than in more productive sectors. This is made possible by the easy access to short-term capital flows and the open capital account. These debts can cause bubbles for example in real estate or the stock market. Government can use tax proceeds as part of counter-cyclical policy. Tax relief is part of a stimulation policy. There is a movement even on the political right towards using monetary and fiscal policy to achieve growth.

Prof Jahed felt that monetary policy focused only on inflation-targeting had been around for too long. This should not be the only priority of monetary policy. Equality, structure and growth are also relevant. He was uncertain that the band of 3%-6% target was still relevant for RSA. He felt that fiscal policy together with monetary policy must be stimulatory.

Mr Carrim asked what three things could be done by government to change fiscal policy in a way that favours growth.

In response to Mr Maynier’s questions, the PBO said that it does not produce a growth forecast, but instead has a forecasting auditor. Is VAT regressive? The consensus is that it is mildly regressive. The zero-ratings basket does have some impact however. A VAT rate hike will naturally increase government tax revenues. In response to Chairperson Carrim’s question, the PBO said VAT is a tool that can be utilised to create these amounts. Wealth taxes will raise R5 billion but that is not enough. There are other protection mechanisms that can accompany a VAT hike that should be considered. There are also other taxes that could be introduced. A fuel levy which is also regressive is seldom spoken about, but this could be introduced with measures to protect poorer consumers. It is important to look at any proposed tax as a member of a system of taxes. Balance between taxes is relevant. Overall, there is a high likelihood that in the next few years a VAT hike will occur.

Mr Amra explained that a tax on luxury goods is an option. Reshaping the zero-ratings basket is an important tool. Capital gains tax is part of the income tax mix and it has increased somewhat already through an increase in the inclusion rate. Increasing corporate tax is a possibility, but corporate taxes alone make up a relatively small share [18%] of total tax revenues. The headline tax rate on corporations must also be considered in a global context. Currently it is unlikely that this rate will increase because it risks dampening the economy. He noted that VAT is somewhat regressive as lower income households spend a greater proportion of their income on foods. Having multiple rates on different goods is a possibility but does require additional administration. Even advanced countries will have long lists of zero-rated items. The budget also has the aim to stabilise the debt-to-GDP ratio. The inflation rate increase that may be caused by a VAT hike will normalise over time.

Ms Nelia Orlandi, PBO Deputy Director: Public Policy, stated that all consumption taxes are regressive and therefore protection of any form is relevant and should depend on the situation at hand. She felt that the biggest issue was the basket of zero-rated goods; the basket needs to be updated urgently. It was last reviewed in the early 1990s. In response to Mr Shivambu, she stated that the biggest contributors to corporate income taxes are from financial and insurance companies followed by manufacturers.

Prof Jahed stressed again the importance of considering the system as a whole and its effects on the economy. There is a somewhat ideological question about the effectiveness of pursuing equity as opposed to efficiency in the economy. In terms of economic discourse, a principle is to tax the rents that arise from market imperfections. The economic definition of rents is any income above the normal rate of profit. Developmental states should aim to tax rents and reduce collusion. However, it is difficult to identify rents as opposed to taxing productive activity which is undesirable. Capital gains taxes are perhaps a better way to tax rents. It is more complicated when it comes to corporate tax as rents and productive incomes are often mixed together. There are certain reductions within corporate and income tax that should possibly also be reconsidered.

[Ms Phosa took over as chairperson]

Ms T Tobias (ANC) asked how the PBO felt the country could invest sufficiently in infrastructure while staying balanced in terms of the budget. What new taxes can we impose to find the balance?

Mr A Lees (DA) asked if the PBO had modelled the amounts of revenue it believes the proposed sugar and carbon taxes would create.

Mr Buthelezi asked what would happen if the country imposed a luxury goods tax. He felt that it was clear government did not want to consider corporate tax on the assumption that one should not tax money that is being invested in the economy. A problem is that there is still insufficient private investment. He argued that a progressive tax is better than a regressive tax because the wealthy do not invest the same proportion of their money compared to poorer people. Although inflation is bad for the economy, it is less important to the South African people than unemployment.

Mr Kwankwa agreed that inflation should not be overly emphasised when the government discussed fiscal and monetary policy. Some interest rate hikes have been over-reactions to moderate inflation. We have a set of economic objectives amongst which inflation targeting is just one.

Mr B Topham (DA) said that the arguments on economic rent made sense theoretically, but asked how government could take practical steps to implement a tax on economic rent. For example, a practical conclusion may be to say that there should be higher taxes in more monopolistic sectors. He was interested to know if this kind of logic had been applied elsewhere in the world and if so how successful it had been.

Ms Shope-Sithole commented that the largest banks such as Investec, Absa and Standard Bank, are not taxed sufficiently.

Ms C Madlopha (ANC) felt that the estimate of the budget deficit did not reflect the true situation. Demand will be lower than what these estimates take account of. There is the adjustment process and the reshuffling of unspent money. She added that the government needs to encourage a culture of savings.

Ms Y Phosa (ANC) referred to slide 7 and asked PBO about the plan to reduce expenditure and increase revenue. What informs the allocation of the contingency reserves? She asked what PBO’s opinion was on private investment acceleration as a strategy to create inclusive growth.

Prof Jahed responded to Mr Carrim’s question about three ways to change fiscal policy to favour growth. He mentioned the need to define policy objectives. Real objectives need to be more specific than poverty and unemployment. These terms are too loose and they do not achieve much – government spending and structures remain the same. An exercise to better define these goals would itself be useful. Then these can be specifically implemented in the budget. He felt that a VAT hike was against common sense given the difficult situation of many consumers. He noted that corporate tax used to contribute a far higher share of total revenue. These entities need to contribute more.

Mr Amra explained that the current growth forecast for GDP over the 2017/2018 period is between 0.8% and 1.1 %. Per capita growth is important because it looks at income on average, which seems to be shrinking. In response to Mr Shivambu, he stated that small and medium enterprises are taxed but informal businesses are not. The strengthening of the Rand improves the inflation outlook. The Reserve Bank is expected to lower short-term interest rates which will be expansionary for the economy. Regarding debt service cost, the repayments are a result of the maturity profile of the debt. The strengthened Rand has also made foreign repayments cheaper.

Prof Jahed responded about taxing economic rents. A typical example is the taxes on businesses in the mining sector. It can also apply to other oligopolistic industries such as telecoms. Taxes can also be placed on businesses with environmental externalities. There are various taxes currently in place within the category of corporate income tax. The country needs to look to the experiences of other developmental countries in implementing various types of taxes. VAT can be used to balance the books in the short-term while in the longer-run the focus is on re-evaluating and balancing the entire tax system.

A PBO analyst explained that PBO was not confident to estimate the amounts of revenue that could be provided from the sugar and carbon taxes without further analysis. The Reserve Bank does have a flexible regime and does let inflation fluctuate outside of the bracket without necessarily using reactionary policy. He felt that the private sector could be stimulated which would lead to more taxable income for government without having to increase corporate tax rates. He pointed out that if a firm colludes and earns higher profits, government would still tax these profits. As such it is not entirely correct to say that collusion directly leads to lower tax revenues.

Ms Orlandi explained the purpose of contingency reserves, which are put away in case there are unforeseeable costly occurrences. Treasury then reallocates the unspent portion of these funds in the budget adjustment process.

Mr Carrim and Ms Phosa concluded briefly. The PBO would report back to the Committee on 28 February.